Home Depot, Inc. In The New Millennium
Assigned Case Questions:
Assess Home Depot’s financial performance from 1986 to 1999. How did the company achieve such a spectacular performance? What explains the decline in performance in 2000? The following data might be helpful in your analysis.
Sales Growth and Profitability Ratios
Average for fiscal years 1986 to 1999
The fiscal year 1999
The fiscal year 2000
Sales Growth Rate
27.2%
19%
Return on Equity (ROE)
25.2%
26.5%
20.9%
NOPAT/Sales
4.7%
6.0%
5.6%
Sales/Net Assets
4.34
3.75
3.53
Operating ROA
19.6%
22.6%
19.8%
Spread
18.4%
22.9%
22.4%
Net Financial Leverage
0.37
0.17
0.05
Financial Le89+verage Gain
5.7%
4.0%
1.1%
How did the company achieve its growth from 1986 to 1999?
Competitive advantage
The home depot had a competitive advantage over its peers in the industry. The competitive edge was as a result of the introduction of the ”big box” hardware merchandising, strategic union low price and high-quality services. These factors gave the home depot an advantage over its peer in the market and leaving them with no option but to leave the market. The companies that remained in the market tried to emulate the ”big box” hardware merchandising, but they failed since the company had gained higher purchasing power over its supplier thus suppressing its competitors: some of the competitors retrenched while other were forced to undergo dissolution. In that account, the company growth rate from 199o to1999 the diluted earnings per share was compounding at an interest rate of 29%.
Operating performance
The company operating performance was superb. For instance, the company had 930 stores in Canada and the USA. Also, the company plan was to increase its market share by a rate of 21% to 25 %. Moreover, these stores ensured that the company had enough cash flow to finance its operating activities and financial and investing activities. Its running performance thus was one of the primary reason for the company starring performance.
Macro-economic factors
The year 1986 to 2000, the company existed in a home improvement industry that had a higher growth rate than the country growth rate. For instance, the growth rate in the year 1998 was 10.8%, which was higher than the economic growth rate at that particular period. The low-interest rates, increase home ownership, and higher housing turn over triggered the home improvement industry growth. In that case, the industry growth was a contributing factor to the starring performance of the home depot company.
What explains the decline in performance in 2000?
Several factors are probable reasons that may have contributed to the decline of the company in 2000. The Federal Reserve Bank had raised the interest rate six times during the period. The higher interest rates caused the consumer demand to decline, and hence the market growth decline. Also, the company had aggressive strategies of expansion . also the main reason (Domowitz, & Hakkio, 2015). Furthermore, the analyst predicted the market growth rate of 4.5 % in the coming years. This declining rate also contributed to the fall of the stock value of the company hence the declining status of the company.
What is your estimate of the intrinsic value of Home Depot’s stock as of February 1, 2001, assuming that it will have: (a) the same sales growth rate as in fiscal 2000 for the next fifteen years, (b) a growth rate of 11% beyond year 15, (c) maintain its fiscal 2000 NOPAT margin for the next 15 years and beyond, (d) maintain its fiscal 2000 net working capital to sales ratio, net operating assets to sales ratio for the next 14 years and beyond, (e) maintain its fiscal 2000 book net debt to net capital ratio for the next fourteen years and beyond, (f) a risk free rate of 5.8%, cost of debt of 6%, common equity beta of 1.09, and a market risk premium of 7%.
The capital price model (CAPM) is equal to risk free (Rf) plus beta (market risk premium les risk frre)
Thus ke =.058+1.09(.07)
CAPM (Ke) == 13.43%
ROE = .209
G = .06
V= BVE * (ROE-g)/ (Ke-g)
12,341*(.209-.06)/ (.1343-.06) = 24,748.44 million dollars
The value, therefore, values from $25.2B to $61.3B. However, the costs depend on the CAPM and market risk premium of approximately 7%. (Merton, 2014) Moreover, the examination of the value of ROE from 20.9% (actual 2000 ROE) to 24.9% (average 1986-2000 ROE) shows the values range from $25.3 to $32.1B. In that case, the valuation of home depot depends on three factors: market risk premium, growth rate, and return on equity.
What set of assumptions regarding Home Depot’s future growth rate, NOPAT margin, are consistent with its observed stock price of $48.20 on February 1, 2001? Assume that all the other assumptions remain the same as in question 2, except for the market risk premium, which is now assumed to be only 4%.
When the market risk premium is low means that the company’s stock is not risky, in that account, the investors will not demand a higher rate of return. In that account, when the market premium risk of the company decreases to 4% from 7% means that the company stock is not volatile and hence the investors can comfortably invest with the company without demanding the higher rate of return. In that account, the cost of equity of the company will decrease (Bakshi, & Kapadia, 2013). The Home Depot company growth will increase since it’s market premium risk will diminish. In that case, the investors will be willing to invest with the company. Consequently, the company growth rate will increase because more investors will be ready to invest with the firm.
Do you think Home Depot can achieve the performance assumptions in question 2, based on its growth strategy?
The company return on equity and its cost of capital are favorable. In that account, the firm properly utilizes its asset. When I base my argument on the values of obtaining in question two, I believe that the company can achieve its strategy since it can get revenues from $25.2B to $61.3B. In that regard, I think the company can better the performance. Also, its return on equity is positive meaning the firm will be able to utilize its assets and capital. In that regard, I do not doubt that the company will achieve its goals.
References
Bakshi, G., & Kapadia, N., (2013). Delta-hedged gains and the negative market volatility risk premium. The Review of Financial Studies, 16(2), 527-566.
Domowitz, I., & Hakkio, C. S. (2015). Conditional variance and the risk premium in the foreign exchange market. Journal of International Economics, 19(1-2), 47-66.
Merton, R. C. (2014). An intertemporal capital asset pricing model. Econometrical, 41(5), 867-887.